Cheques cancelled

A half-hearted effort to modernise America's Byzantine payment system

AMONG the less-publicised side-effects of the terrorist attacks on America in September 2001 were growing piles of cheques in banks across the land. Because air traffic was at a standstill, banks were unable to process them. Americans are still heavy users of paper cheques (see chart), and the banks at which they are deposited must send them to those on which they are drawn, perhaps thousands of miles away. Many Americans, indeed, still receive wads of their cancelled cheques with their monthly statements.

Regulators concluded that any system based on scribbles on pieces of paper passed from hand to hand and institution to institution before being returned to their authors is probably inefficient and possibly risky. So a year ago Congress pushed through the Check Clearing for the 21st Century Act (known as Check 21), which is intended to hasten the adoption of electronic processing. It comes into effect on October 28th.

There is a chance that this will hasten change that is going on anyway. Most of the world has long since come to terms with electronic payments, and Americans are hardly unfamiliar with plastic cards and the internet. And for banks, the potential saving from not having to cope with a daily avalanche of paper slips could reach $2 billion annually, according to Prudential Securities, albeit at an investment cost of up to $10 billion. Yet it is hard to be sure that the law will change all that much.

If customers notice any difference because of Check 21, it will be that their bank statements carry photocopies of cheques, not originals. The system producing these copies will be remarkably complex. As now, anyone paid by cheque will deposit it in their bank, to be sent on to various clearing houses, which route the cheque back to the issuer's bank for payment approval and the transfer of funds. However, the new system will allow the bank that first receives the cheque to create an electronic image for transmission through the system. This image can be reconstituted into a paper cheque by the drawer's bank. Banks will no longer have to fly paper cheques across the country, but the new system will be costly too—worthwhile only for fairly large payments drawn on banks far away. Many banks may stick with the old system.

Regulators say that they have not pressed for a more radical change because they do not want to swamp banks with new rules. And if Americans want to use paper cheques, they should be able to. The country's attachment to this means of payment is a long one and, although it is fading, it is doing so slowly.

Partly, cheques have endured because they are a cheap form of documentary evidence of a transaction. Their longevity is also partly explained by America's peculiar banking geography. In most countries where electronic payment networks were quickly established, there were just a few national banks. Until recently, in America banks were confined to small areas. There are still about 15,000 of them. Exchanging bits of paper on a local basis was not too expensive; conversely, now that such a system is in place, creating electronic links between several thousand institutions is not easy.

Banks have also done a good job bringing down the costs of processing cheques. Each one costs just a few pennies, reckons Carl Rutstein, of the Boston Consulting Group. Even the most efficient new systems would save only about $2 per account, or about 1% of revenues. That is hardly enough to provide a new service, or radically new pricing.

The greatest disincentive, however, is that even though a new electronic system could cut banks' costs, their revenues might fall too. Under the current system, banks can take days, even weeks, to clear cheques. Meanwhile, they earn billions of dollars from this “float”. And lots of cheques bounce, producing plenty in penalty fees. With fully electronic payment systems, settlement could be far faster than it is now; if funds were unavailable, this could be plain almost immediately.

Little wonder, then, that the financial system is in no hurry to modernise. The real pressure for change is not coming from regulators, or banks, but rather from the market: cheque usage has been in slow decline for years. If banks do build electronic networks that are more resilient than the paper-based systems that made them vulnerable in 2001, it will be their customers that deserve the credit.